Diversification made easy

THE expression 'never put all your eggs in one basket' describes one of the key rules of investing.

Right now plenty of Australians have significant funds invested in savings accounts and term deposits. These are very safe options but without the benefit of long term capital growth, you could be short changed further down the track.

Sharemarkets globally have delivered a wild and very unsettling ride since the GFC, with great volatility continuing. No one likes this, however it's also important to remember that quality shares also offer dividend yields in the order of 4% to 5% annually. Unlike the interest you'll earn on a bank account, which is fully taxable, franking credits on dividends can boost your after-tax return by 30%.

Also remember that many shares are much cheaper now than they were previously. Buying good assets at a low price, when the market's down, is one of the most proven ways of building wealth over the long term. You just need patience, and nerve, to do it.

The commercial property market also offers opportunities, yet it's an investment class that can be difficult for ordinary investors to access.

That's where diversified managed funds are useful. They provide access to a broad range of investments, without the need for significant upfront cash.

Diversified funds hold a variety of assets spread across a number of investment markets. They can be divided into three general categories - 'capital stable', 'balanced' and 'growth' funds. However many funds go by various marketing names that don't always make the underlying investment approach crystal clear. That's why it pays to read the fund's product disclosure statement (PDS) to get a good idea of how your money will be invested. Capital stable funds mainly invest in cash and fixed interest securities (like government and corporate bonds), sometimes with a small percentage of shares and property assets thrown in. These funds can be suitable for investors looking for regular, steady returns.

If you're looking for capital growth accompanied by some regular income, it's worth thinking about a balanced fund. These have around 70% of the fund's investments in growth assets like shares and property, often with the balance held in cash and fixed interest. You should be prepared to hold onto your investment for around three to five years.

Further along the spectrum, growth funds focus chiefly on growth assets with only a small holding of cash and income assets. This asset mix means you should hold onto this type of fund at least five years to allow for swings in the underlying asset classes.

The type of fund that's right for you depends on a variety of factors including your age, personal goals and how you feel about risk. But with thousands of managed funds to select from, there's bound to be one that suits your needs. Managed funds are offered by many of our large financial institutions. Or, you could think about an exchange traded fund (ETF).

ETFs are listed on the Australian Stock Exchange, and represent an underlying index or portfolio, or in some cases, a commodity like gold.

Like traditional diversified funds, ETFs can offer exposure to a diverse portfolio. They are also very cheap as no entry or exit fees apply, though you will pay brokerage when buying and selling ETFs. The annual fund management fee can be as low as 0.09% annually compared to up to around 4% with traditional managed funds.

For a complete rundown on how managed funds work - and why diversifying is so important for investors, take a look at the new edition of my book Making Money.

Paul Clitheroe is a founding director of financial planning firm ipac, chairman of the Australian Government Financial Literacy Board and chief commentator for Money magazine. Visit www.paulsmoney.com.au for more information.